. Assume the Federal government runs a budget deficit in the current fiscal year
ID: 1219617 • Letter: #
Question
. Assume the Federal government runs a budget deficit in the current fiscal year. i. How can the Federal government fund the deficit? If federal revenues and government spending are equal in a given fiscal year, then the government has a balanced budget. If revenues are greater than spending, the result is a surplus. But if government spending is greater than tax collections, the result is a deficit. The federal government then must borrow money to fund its deficit spending. ii. If the Federal government decides to issue U.S. Treasury securities to fund the deficit, what happens to the level of national debt, all else held constant? iii. Assuming the Federal government and firms compete for the same savers’ dollars in the loanable funds market, what is likely to happen to interest rates? iv. Given your answer in (iii) above, is crowding out more or less likely to occur if the deficit is funded by Treasury securities? Explain.
Explanation / Answer
Answer 1:
The size of the budget deficit in any given year is determined by two factors- amount of money that government spends each year and amount of revenue that government collects in taxes. To finance the debt, the U.S. Treasury sells bonds and other types of securities. Anyone can buy them form the website or from banks or brokers. Thus loans are given to the federal government in exchange for repayment with interest at a later date.
Answer 2:
If Treasury Bills are used to finance the debt of the government, then all things held constant, the national level of debt of the country will rise.A lower level of investment will occur which will slow economy's growth.
Answer 3:
Since, increase in the level of public debt from the market will reduce the savings to be utilized by the private sector for investment. Thus, reduction in the amount of savings available for private investment will lead to rise in the level of interest rates. This is known as crowding out of private investment.
Answer 4:
Since treasury securities provide a certain source of income to the savers and are risk free. So, it is more likely that savers will invest in TBs as compared to private projects which do not guarantee a certain source of income. Thus, crowding out is more likely to occur if the deficit is funded by Treasury securities.
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